Nice to see you again, Mr. Godzilla

A few years ago I predicted the “Godzilla of all bond rallies” once QE II ended. Let’s revisit this prediction, and talk for a minute about a recent post a certain Mr. Roche concocted over at PragCap.

First, how did the prediction fare? Excellent! After I posted about a huge rally in bond prices (and the related fall in bond yields), the bond market rallied tremendously!

Here is the first chart I posted.


You can see how this chart is from early March, 2011. In it, I lay out how the bond market is likely to rally (and yields fall tremendously) once the Fed ended QE II.

I claimed this was from a “cash to clunkers” effect, where weak holders of bonds would want to sell to a strong buyer before that buyer went away.



The prediction was spot on!  Here is the next chart, showing the dramatic fall in yields once QE II ended, and the pathetic rise in yields since QE III started. 


You can see how the end of QE II did in fact spark a huge fall in yields, and a gigantic bond rally, when it ended. I don’t know what every bond trader in the world thinks, but I can tell you knowing a massive buyer will go away in 45 days puts a bit of pressure on you if you are thinking about selling at all.

So, how about QE III and the chart by Cullen? Cullen points out that QE III is having very little impact on commodity prices, and not much impact on equity prices either. Here is a very good chart he puts up to show just how little impact QE III is having on commodities. Here are a few interesting questions from CR:

“It all makes you wonder – is there a real fundamental driver behind QE or is it mostly psychological as I’ve been saying for a long time now?  How could such a dramatic disconnect exist if there is so much more money in the system chasing fewer and fewer asset classes?  ”

According to the conventional view of how QE works, QE III is pushing even more marginal money into a system, chasing after less total assets. This is the entire point of QE! At this point, commodities should be so hot they are melting upwards everyday. But QE III has turned out to be a bust for commodities. It hasn’t changed expectations much for government bonds either.

QE III is open ended. It’s all about the expectations channel. And it’s working a bit – housing is recovering. But do we want housing to recover? Is more houses really the best way to get our economy back on it’s feet?

Not only that, but we’re probably starting to get far above replacement value on homes again. In other words, building new houses will be extremely profitable. So profitable that there will probably soon be a glut of housing, which of course is not very good for housing prices.

Welcome to the boom/bust world of Godzilla in the bond market. Where QE goes on and forces up housing prices, until expectations stall and the fed is left holding worthless MBS and triggers a massive rally in government bonds. .

We’ve nationalized housing by following the advice of people who can only think in one color.


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5 Comments on "Nice to see you again, Mr. Godzilla"

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4 years 3 months ago
Interesting Article over at the Testosterone Pit: Housing Bubble II: But This Time It’s Different “We have seen it for several years now: foreclosure sales—there were 5 million since the peak of the housing bubble—have become the hunting grounds for investors with two goals: hanging on to these homes until the Fed’s flood of money drives up their value; and defraying the expenses of ownership by renting them out. And funds have a third goal: collecting management fees. Thousands of smaller investors have piled into the game. And so have the giants. Blackstone Group LP, the world’s largest private equity firm, plowed over $3.5 billion into the housing market, according to Bloomberg, to gobble up 20,000 vacant and foreclosed single-family homes. It just fattened up a credit line to $2.1 billion to do more of the same. Colony Capital LLC, which already owns 7,000, is putting $2.2 billion to work. Last year, institutional investors made up 19% of all sales in Las Vegas, 21% in Charlotte, 23% in Phoenix, and 30% in Miami. It had an impact. In the latest Case-Shiller report—a three-month moving average for October, November, and December—home values soared 9.9% in Atlanta, a bigger jump than even during the peak of the housing bubble. Las Vegas popped 12.9%, and Phoenix 23%. It’s getting hotter. In February, compared to prior year, asking prices jumped 14% in Atlanta, 18% in Las Vegas, and 25% Phoenix. Seen from another point of view: in January, the median price of a single-family home in Phoenix skyrocketed 35%. “We recognized that prices were moving faster than people expected,” explained Devin Peterson, a Blackstone real estate associate, to Bloomberg. Despite that, they’re still “finding opportunities to buy.” They might not be able to rent them out very quickly, but they’d rather not be “missing… Read more »
4 years 3 months ago

This is the sort of thing I was asking about:
“The demand is not only coming from registered funds, but also from hedge funds as well as CLOs, (companies that securitize these loan portfolios). CLO volume clocked at $52 billion last year, while market participants expected only about $15 billion for 2012. The expectation for 2013 CLO issuance is $65bn according to JPMorgan, and all that collateral will have to come from somewhere.

As market participants rotate out of HY bonds, which have been frothy for some time (see post), and into loans, we are seeing the beginnings of another QE-driven market frenzy. Covenant-light transactions are a large part of the primary market recently,
JPMorgan: – … the number of covenant-lite deals priced in the leveraged loan market also remained heavy. Specifically, covenant-lite loans accounted for 41% of issuance this week ($10.5bn), which followed $18.9bn (53%) last week, $14.7bn (47%) in January, and $58bn (51%) in 4Q12.
… and deal leverage is increasing as well, with an average LBO at 5.5 times (according to S&P). This is still below the 6.2 record level reached in 2007, but in terms of the overall leverage we are roughly where deals priced during the 2005- 2006 period.

When the Fed looks for signs of liquidity-driven market pricing, the central bank won’t need to look too far. The question is, are they looking at all?”

4 years 3 months ago

This time around is the QE money going to corporate loans? So the holders of MBS or treasuries ask a bank to sell them to the fed. The bank gets reserves, the client gets bank deposits and those are used to buy securities derived from corporate loans?
Might finally QE be doing what it was hoped to do? It just took this long for the financial system to work out what to do? Could low interest lending to non-financial companies via shadow banking arrangements even help the real economy?